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Indo Gulf: New highs - Views on News from Equitymaster
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Indo Gulf: New highs
Jul 18, 2005

Performance summary
Indo Gulf, one of the most cost efficient producers of urea in the country, announced its 1QFY06 results. While topline growth at 9% is encouraging, operating margins improved notably. This was primarily on account of savings in raw material and power costs, which is in line with our expectations. Despite a sharp fall in other income, net profit grew by 18% in 1QFY06.

(Rs m) 1QFY05 1QFY06 Change
Net sales 947 1,030 8.8%
Expenditure 784 829 5.7%
Operating profit (EBDITA) 162 201 23.6%
EBDITA margin (%) 17.1% 19.5%  
Other income 65 30 -53.3%
Interest 5 5 0.0%
Depreciation 100 95 -5.0%
Profit before tax 123 131 7.0%
Tax 43 37 -13.6%
Profit after tax/(loss) 80 94 18.0%
Net profit margin (%) 8.4% 9.1%  
No. of shares (m) 45.1 45.1  
Diluted earnings per share (Rs)* 7.1 8.4  
Price to earnings ratio (x)   16.6  
(* annualised)      

What is the company's business?
Indo Gulf, an Aditya Birla Group Company, has presence in the urea segment with an assessed capacity of 865,000 MT (metric tonne). The manufacturing facility is located in Jagdishpur (Eastern India), which is towards the end of the HBJ gas pipeline of Gas Authority of India Limited (GAIL). Therefore, Indo Gulf has access to gas, which makes its operations relatively cost-effective. The company’s presence in the Eastern market is of significance because of the fact that almost 60% of the urea consumption is accounted for by the Northern and Eastern markets.

What has driven performance in FY05?
Production at new highs:  During the quarter, urea production stood at 0.25 MMT (million metric tonnes), which represents a capacity utilisation of 117%, which is commendable. Urea sales stood at 0.66 MMT and was higher by 17% YoY. We believe that urea demand is likely to grow by 3% to 4% overall and the company is in a position to outgrow the marginally, though marginally in FY06. As we go forward, the company had submitted an application to expand capacity by de-bottlenecking in April 2004 and the approval is still pending. But as per the last analyst meet, the company is going ahead with the expansion plan on the premise that it will be able to receive necessary approvals.

Cost schedule…
(Rs m) 1QFY05 1QFY06 Change
Raw materials 844 812 -3.8%
% sales 89.1% 78.9%  
Change in stock (539) (404) -25.1%
% sales -56.9% -39.2%  
Power and fuel 240 175 -27.0%
% sales 25.3% 17.0%  
Salaries 77 90 17.0%
% sales 8.1% 8.7%  
Other expenses 165 156 -5.3%
% sales 17.4% 15.2%  

Increased gas usage boost margins:  In the last two years i.e. FY04 and FY05, the company's raw material costs to sales had shot up owing to increased usage of naphtha. This was on account of erratic supply of gas by GAIL. However, Indo Gulf entered into an new agreement for supply of gas at higher prices and consequently, there has been an improvement in availability. This, in turn, has resulted in lower naphtha usage and has provided a boost to operating margins. Even after taking account the recent gas price increases, we believe that the margin outlook remains positive.

Other income effect:  The growth in net profit at 18% is commendable, is despite a 53% fall in other income. The reduction in corporate tax has lowered the effective tax rate in 1QFY06, which in turn has boosted profits. If one were to consider the performance of the company over the last few quarters, there has been a steady rise in capacity utilisation owing to higher on-stream production days. Though operating margins have been volatile, we believe that margins are likely to steady going forward.

What to expect?
At the current price of Rs 138, the stock is trading at a price to earnings multiple of 6.1 times our expected FY08 earnings. We have exercised caution as far as gas prices are concerned going forward and even after the same, the outlook is positive. If the company receives the approval from the government for the expansion, it will be an added positive. We had recommended the stock Rs 124 in May 2005 with a target price of Rs 170 with a two year perspective. We maintain our view.

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